Small businesses and their financial difficulties – the Ombudsman’s inquiry

A discussion paper[1] issued on 20 December from the Insolvency Practices Inquiry of the Australian Small Business and Family Enterprise Ombudsman examines the financial difficulties of small business and the impact of an insolvency administration on them.

Feedback is sought on what would be a ‘best practice framework’ for both small businesses moving towards insolvency and ‘the professionals that support them during that process’. Submissions close on 27 January 2020.

In the meantime, ARITA, one of Australia’s insolvency industry bodies, has commented on the discussion paper.

The paper says that

“small business owners felt there was a loss of control and a lack of transparency throughout the [insolvency] process; and with these businesses often being wound up, appeared poorly managed and resulted in less than ideal outcomes both for the owner of the business and its creditors”.

Corporate businesses only

As an initial comment on the paper, although a good proportion of small businesses operate as individuals, and although corporate insolvency can lead to personal liabilities of the directors, no coverage is given by the paper to personal insolvency.

The discussion paper therefore looks only at the framework for corporate insolvencies,

‘key pain points experienced by small businesses …and the actions required by registered liquidators under current legislation’.

Delay in seeking help

The paper says that a key message from the practitioners and other service providers is that small businesses experiencing financial difficulty wait too long before seeking professional advice and assistance. They

‘ignore the signs of financial distress, hoping or believing that things will improve, until it is too late. Where they do seek help early, the current system appears self-defeating as the costs of a voluntary administration often consume or exceed the assets of the company’.

The question of delay in seeking assistance is common internationally, possible answers being the allow more debtor in possession type processes, to develop pre-packs and to relax the independence requirements of insolvency practitioners which may inhibit their full ‘advice’.

Its technical questions

Although the paper says it is looking for a ‘best practice framework’, it goes on to ask a number of rather ‘technical’ rather than fundamental questions as to:

• Whether a liquidator be required to provide a small business with more information and reasons for recommending [advising?] a particular course of action to the directors?
• Whether fees should be controlled so as not to consume the value of the company’s assets [if any?].
• Whether creditors should be better informed of the cost of court proceedings?
• As to the use of technology
• Whether valuations should be provided to, and proposed marketing strategies require approval from, creditors?
• Whether preference demands should be supported by evidence?
• Whether directors should be required to undertake specific education on running a business and the potential risks of personal liabilities?
• Whether the safe harbour laws can be improved to encourage small businesses to take action early and gain time to assess the viability of the business?
• As to how accountants and bookkeepers can best support small businesses to seek help early?
• Whether increased funding and resources should be provided to the financial counselling sector to enable it to provide services to small businesses experiencing financial difficulty?
• Whether the mental health of small business owners and directors should be cause for a pause in proceedings?

The paper says that general submissions are also sought on the ‘fairness of having one system’ and the ‘benefits and risks of implementing different processes so the costs and time to complete an insolvency administration ‘achieves the optimum outcome for creditors, employees and the company’.

An international report

Far more insightful is a report out of an UNCITRAL meeting this month December 2019 on the insolvency of small business internationally, which is an issue across all jurisdictions.

It looks at some fundamental structures needed – for example, a combined regime for personal and corporate liabilities; streamlined default insolvency processes subject to any creditor or regulator intervention; the need for the state to address assetless insolvencies; the extent to which an insolvency practitioner is required, and more.  See www.uncca.org.au.

Australian reports

There are also previous recommendations for streamlined insolvency processes from a 2015 Productivity Commission Report. And the government’s idea for a government liquidator remains on the table. Many academic and professional recommendations also exist.

Supportive business environment

In the end result, in a competitive market economy, running a business will be demanding and failure is inevitable. Survival of the fittest is said to provide the best outcomes. That does assume proper regulation of the business environment – competition, tax and employee laws; and transparent and free access to business data and information.

Australia does not offer that much support to business in relation to those background matters, as its international rankings show.

Who pays?

As to who pays, there have been so any recommendations over the years for a small fee on each company registration to fund a government or other role in small business insolvency. Beyond that, our privatised corporate insolvency profession does not offer much for MSMs in difficulties but our extensive network of accountants, lawyers, counsellors and business advisers does, or should.

As to who pays, Michael Kirby has written that it should not be the professionals engaged to assist, which ARITA [below] suggests is the case:

‘the task of insolvency administration is inherently expensive. Principally this is so because of the intensive nature of the investigation of accounts (sometimes in a shambles and sometimes deliberately deceptive) that the insolvency practitioners must analyse and understand. This is also true of legal costs. All my life, I have known litigants asserting vehemently the justice of their claim, but unwilling to appreciate that securing an outcome is inherently costly. It is unreasonable to demand that skilled professionals should perform their functions at low cost. Dispute resolution has a cost component. Especially where the disputes are complex and contestable, as many involving insolvency are …’.[2]

ARITA

ARITA comments that it will respond to the paper and notes that, as is evident from ASIC’s latest statistics,

‘in the majority of insolvencies, there’s not even enough money or assets left to cover the actual cost of the legally required insolvency processes’.

ARITA goes on to say that Australia’s 650 liquidators

‘collectively ha[ve] to write-off around $100 million per year in unrecoverable fees largely because of government red tape’.

This comment will no doubt be further explained and substantiated but at the moment it doesn’t serve anyone well without more, suggesting as it does some inadequate assumptions of business risk.

ARITA says that its

‘fundamental and long-standing proposition’ is that businesses seeking help early ‘means getting proper, qualified help well before [they] need to consider any insolvency or bankruptcy process’ and that the ‘best help for those in financial distress will generally be from an ARITA member’.

In that respect, ARITA legal, accounting and restructuring members comprise other than insolvency practitioners who can give independent advice as to whether a liquidator or trustee should be engaged.

Offering some support for a ‘debtor in possession’ model, ARITA comments on the loss of control upon the appointment of an insolvency practitioner under Australian law.  Behavioural studies support that loss of control as being a factor against a business person entering insolvency.

ARITA announced its proposed ‘Financial Recovery Law Reform Commission’ earlier this year.  While details remain to be announced, ARITA explains that it will ‘run during 2020’.

ARITA’s initiative will assist in the development of Australia’s insolvency system.

More?

Soon.

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[1] Insolvency Practices Inquiry, Discussion Paper, December 2019

[2] Bankruptcy and insolvency: change, policy and the vital role of integrity and probity, Insolvency Practitioners‟ Association of Australia National Conference Adelaide, South Australia Wednesday 19 May 2010.